Inverse Market Options

Harsh droughts are not fun. And, relative to expected yields, the 2012 corn crop will go down in history as one of the five worst in the last 100 years. Drought-damaged crops and early harvests go hand in hand. Maybe this is for the better – finish harvest quickly and put this year of disappointment in the rearview mirror.

Drought-damaged crops and bull markets also go hand in hand. How strong is this bull market? After showing a carry of nearly 28¢as recently as mid-June, the Dec’12/Jul’13 spread in corn has inverted (December at a premium to July). A Dec/Jul corn inverse is a rare event, happening just three times in the last 50 years: the fall of 1983, the summer of 1988 and very briefly in the fall of 1995. (These are years of comparable interest, and we will return to them later). The soybean market is also sporting a strong inverse.

Between a small crop and too many early sales, not many producers are left with the challenge of what to do with surplus production. If you happen to be one of the lucky ones, let’s consider a short list of your post-harvest marketing alternatives when grain markets are inverted. These include selling at harvest, storing grain for sale later in the crop year, and re-owning earlier sales with the purchase of call options.

In corn and soybeans, I’m leaning towards a mix of harvest sales and storing a portion of the crop for sale later in the crop year. I remain a corn basis bull, and this will help drive half of the “futures + basis = cash” equation higher. We’ve seen corn basis “overs” in each of the last two years, and I expect them again next spring. My concern is the futures market. At levels close to $8 and $15/bu. respectively, July corn and soybeans were not cheap. Holding unpriced grain in storage will take some nerve. Don’t get complacent and have an exit plan for both a higher and lower price scenario.

How about re-owning earlier sales with the purchase of call options? I’m no lover of options, but this type of year – a year with strong inverses – offers the best chance of success.

Looking ahead to 2013:

Farm management experts project modestly lower production costs in 2013. The drought has driven 2013 corn and soybean prices to attractive levels. Can past drought-year crops like 1983, 1988 and 1995 help us understand the best time to start pricing grain in the year following the drought?

The severity and early start of this summer’s drought is similar to 1988. The 1983 drought was also severe, but struck later. Both of these years showed that “short crops have long tails” –- the best time to have made sales for 1984 and 1989 was during the price run-up 15 months before harvest (see chart).

Yields in 1995 were a disappointment, but not in the same category as 1983, 1988 or 2012. So why look at 1995/96? Because strong demand and an extremely tight stocks situation in the 1995 crop year remind me of how 2012 differs from 1988 and 1983. The 1995 short crop had no tail -- the best time to price the 1996 crop was in the spring and early summer of 1996.

Tight-stock bulls say “wait for a higher price” and long-tail bears say “price now.” History has fodder for both arguments. Either way, don’t lose sight of the fact that in each of these years, harvest prices in the following year returned to pre-drought levels.